How Potential US Car Tariffs will Wreak Havoc on the Global Economy and Why it’s Being Used as a Negotiating Tactic
Last week, US President Trump asked for a sweeping trade investigation into whether autos imported into the United States pose a threat to national security, requesting the Commerce Department led by Wilbur Ross to explore whether car imports pose a threat to America’s national security. With a US Auto Industry dependent on imported Car Parts from countries like Mexico & Canada and US Consumers dependent on affordable cars, this tariff has sparked outrage across the industry, trade partners, congressmen and consumers alike. However, while the notion of car tariffs is shocking and unsettling to many, the actions suggest this will be used simply as a tactical bargaining chip related to NAFTA renegotiation talks.
This probe that could ultimately result in tariffs on foreign-made cars and further strain relations with global allies. This investigation, conducted under Section 232 of a 1960s trade law, is the same tool the president invoked in imposing global tariffs on imported steel and aluminum earlier this year and due to be implemented on June 1st. An additional tariff on vehicles of up to 25% is under consideration which would raise prices on cars for US consumers.
What is the Impact on the US Auto Industry?
The potential ramifications and fallout from car tariffs on the US Auto Industry would be vast and impactful. To define the US Auto Industry further, we look at both direct and indirect jobs totaling approximately 7.25 million jobs or 3.8% of the private-sector employment labor force. This includes employment jobs from Automakers (2.44 million), Auto Dealers (1.65 million) and Auto Suppliers (3.16 million), comprising the most direct ecosystem that may be affected. In terms of manufacturing workers, the Detroit Big Three directly employ 181,000 US workers while Japanese companies with manufacturing facilities in the United States directly employ 67,000 total US workers. According to Rutgers University, more than 1.36 million direct and indirect manufacturing jobs in the U.S. are because of Japanese automakers, and they are only expected to grow.
Automobiles contribute 10 percent of all exported US goods, amounting to $158 billion in 2017 alone, which would be at risk if trading partners mounted a backlash. On the other hand, to put automotive vehicle imports into perspective, it constitutes the fourth-largest import category with $359 billion in vehicles, parts and engines. Ranked globally, the United States is the number one importer of cars at $180 billion, comprising 24% of all global auto imports. However, a significant number of “foreign cars” are actually manufactured and assembled within the United States at various plants across the country. Abandoning these manufacturers for the sake of “saving” Detroit’s Big Three would be akin to shooting your left foot to save your right hand as many US jobs would be negatively affected.
Sources: Cars.com, Automakers, Automotive News
How is the Republican-led Congress Responding?
The US Consumer would be the biggest loser should the United States proceed to enact trade tariffs on car imports as they’ll be faced with staggering price increases on their favorite cars such as the Toyota Camry, Honda Accord and Toyota Sienna. Not surprisingly, Republican lawmakers have their finger on the pulse, especially during a critical election year where the GOP is seeking to maintain control of Congress. Longtime, staunch supporters of Free Trade, the mere suggestion of the huge tariffs has sparked an immediate backlash on Republican-led Capitol Hill, as well as GOP-friendly business groups who loath such a tax on the industry.
“I hope we can avoid getting into any kind of tariff situation,” Senate Majority Leader Mitch McConnell (R-Ky.) told Fox News. “I think all of us are hoping that all of this back and forth discussion about trade doesn’t end up leading into the implementation of tariffs or some larger trade war.” To be sure, the United States is by far the biggest importer of cars worldwide, more than doubling that of the second-largest importer, Germany, as US consumer’s appetite for vehicle imports remains robust.
How have Trade Partners Responded?
Looking at countries that will be most affected by car tariffs, it’s notable to point out that the top 6 countries are all strong US Military Allies, so the notion of invoking tariffs on the premise of national security is economically illogical and unfounded from a strategic perspective. Here are the top 6 countries from which the US imported cars in 2017 with corresponding total sales amounts:
- Canada – $43 billion
- Japan - $40.7 billion
- Mexico - $30.6 billion
- Germany - $20.8 billion
- South Korea - $16.1 billion
- United Kingdom - $8.8 billion
A full 98 percent of American imports of passenger cars last year came from key and strategic American allies. Notably, China ranks 10th on this list at $1.8 billion so this tariff strategy doesn’t align with the Administration’s previous attacks against China’s export machine. The economic impact will be felt most severely on US military allies, assuming the tariff would be universally applied across all importers. Contradictorily, one could make a case for the proposed implementation of these tariffs being an actual threat to national security rather than vice versa. Trump has directly indicated that he resents Berlin’s trade surplus, which amounted to $16.7 billion last year in the auto industry alone when accounting for US exports to Germany.
The European Union, Japan and other allies are already challenging the Trump administration’s claim that imports of steel and aluminum – which are used in military equipment - put American national security at risk. Furthering that argument to automobiles would probably be met with even greater skepticism and trade experts suggest this will prompt legal challenges at the World Trade Organization. While it is true that Imported Automobiles are gaining market share up to 35% in the United States, many of these vehicles are manufactured directly within the United States by US-based employees.
What does this mean for US Consumers?
If car tariffs are enacted on trade partners, the net effect would be an increase in the price of cars bought in America, hurting the US consumer’s wallet. As a major expenditure household item and an insatiable need for cars given America’s highway & suburb system, aggregate demand will buy less cars at this higher price (illustration below). On the other hand, domestic carmakers will supply more cars while taking away market share from Foreign Importers (size of dark black line reduces) that account for the difference between domestic demand and supply. However, this is only one side of the equation – the finished vehicle product – and doesn’t account for the higher cost of imported car parts used to manufacture the vehicles, which will increase a carmaker’s cost of goods sold. On the Auto dealership side, which employs a not-insignificant number of 1.65 million Americans, the lower number of total cars sold will undoubtedly eat into each dealer’s commissions as they work in volume. The net result will be less cars sold at higher prices and US consumers being forced to spend more on their car purchases.
Will Car Tariffs Help or Hurt the US Auto Industry?
The car tariff proposal drew a swift backlash from the car industry. Auto industry representatives said they worried that the plan could raise prices for cars and trucks in the United States, contributing to a less competitive American industry and fewer choices for American consumers. Industry executives have previously warned that a potential car tariff would have a huge negative impact on the economy.
"To treat auto imports like a national security threat would be a self-inflicted economic disaster for American consumers, dealers and dealership employees," Cody Lusk, president and CEO of the American International Automobile Dealers Association. Cody Lusk has said that, while the president has made no secret of his disdain for imports, the decision to launch an investigation came as a surprise. “No one on the autos side is clamoring for this. It’s a solution in search of a problem and a new tax on American consumers,” he said.
More surprisingly yet, everybody in the automotive industry was taken aback by this new investigation and nobody had previously requested protectionist measures. “If these reports are true, it’s a bad day for American consumers,” said John Bozzella, the chief executive of Global Automakers, a trade group. “To our knowledge, no one is asking for this protection.”
While some carmakers have welcomed some of the measures proposed by the Trump administration due to the view that maybe some domestic players will gain a home-field advantage, they have criticized at the White House’s approach to NAFTA and its steel and aluminum tariffs, which they say will raise prices and ultimately be passed on to consumers and are scheduled to go into effect June 1st. Finally, many auto suppliers also depend on China, with which the White House is locked in a trade dispute, for parts they cannot source in the United States.
How are Investors Reacting?
What is most surprising of these protectionist policies is that they’re being initiated during a time of economic boom with Annual US Vehicle Sales climbing to its pre-recession level of around 18 million per year. Typically, protectionist tariffs are commonly implemented during recessionary time periods when governments are seeking to give their domestic manufacturers an advantage to jump-start the economy. Accounting for the two-sided impact on US carmakers – higher import prices of car parts versus larger domestic market share and increased pricing power – Ford and General Motors finished mostly unchanged on the week ending May 25th. Taking a look at CrowdThnk Consensus Positioning Scores, General Motors has a neutral score around 3.9 while Ford is slightly overweight at a score of 7.9. Year to date, Ford has fallen -8.8% while General Motors has similarly fallen -9.2% this year.
The Bottom Line: The Bargaining Chip & Implications on NAFTA
Reading between the lines, Trump is clearly linking this new trade investigation with the ongoing talks over a re-drafted North American Free Trade Agreement. It is no coincidence that Mexico and Canada rank #1 and #3 on the Importer list, respectively, combining for nearly 50% of all auto imports into the United States. The NAFTA negotiations have largely stalled over legislation related to auto vehicles - including how much of a car’s content must be manufactured in North America and the United States – in order to qualify for NAFTA’s zero tariffs policy. Currently, the United States levies a 2.5% duty on imported passenger cars and a 25% tariff on pickup trucks from countries that are not its partners in free-trade agreements.
Thomas Donohue, the president of the U.S. Chamber of Commerce, said in a statement that the auto tariffs aren’t “about national security” but that the administration is trying to use trade penalties as leverage in separate, larger negotiations, such as NAFTA. He added that the proposal, if carried out, “would deal a staggering blow to the very industry it purports to protect and would threaten to ignite a global trade war,” he said adding, “Section 232 authorities should not be abused in this way.”
Similar to the Administration’s handling of the steel and aluminum tariff threats that were used as a tactic to coerce other nations to agree to more generous trade agreements, this “investigation” and threat of imposing car tariffs has the guise of a negotiating tactic. Quite explicitly, the US said it would consider lifting possible steel & aluminum tariffs to Canada and Mexico only if they concede to White House demands for renegotiating NAFTA. As cars are at the crux of the NAFTA negotiations, this ploy was undoubtedly thrown into fray to influence negotiations.
Furthermore, the timetable is looming with a deal eyeing to be struck before July 1st, which is the expiry date of the president’s authority to negotiate trade deals that Congress must approve or reject without amendment. Coincidentally, this is the same date of Mexico’s presidential election where the front-runner, populist Andrés Manuel López Obrador, would prove a tough negotiating partner if the negotiations end in a stalemate past June. Finally, the US mid-term elections are looming in November and Democrats are well-positioned to recapture the House of Representatives, further complicating prospects of a congressional approval of a trade deal.
With a wide array of stakeholders opposing a potential car tariff - ranging from Republican congressmen, global trade partners, strategic military allies, US consumers, and not least, the American automobile industry itself – the US Administration would be remiss to pass such a piece of legislation. Instead, they’re more than likely using this as a bargaining chip to increase their odds for concessions heading into the final days of the NAFTA negotiation. As the world’s largest importer of cars and car parts, a US car tariff would cause disruptive reverberations across the globe and would be harmful to both domestic and global economic growth. Keep an eye on further concessions from Canada and Mexico during NAFTA talks as these two countries stand the most to lose should such an economically-neglectful tariff be passed.